Accounting Policies

9 Months Ended

Sep. 30, 2011

(3) Accounting Policies

In accordance with fresh start accounting, all assets and non-interest bearing liabilities were recorded at fair value on the Effective Date. Subsequent to being recorded at fair value, except for certain materials and supplies as noted above, these assets and liabilities continued to be accounted for in the manner in which they were accounted for prior to the Effective Date.

(a) Presentation and Use of Estimates

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which require management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates. The condensed consolidated financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown, including normal recurring accruals and other items.

Examples of significant estimates include the allowance for doubtful accounts, revenue reserves, the recoverability of property, plant and equipment, valuation of intangible assets, pension and post-retirement benefit assumptions and income taxes. In addition, estimates have been made in determining the amounts and classification of certain liabilities subject to compromise.

(b) Revenue Recognition

Revenues are recognized as services are rendered and are primarily derived from the usage of the Company’s networks and facilities or under revenue-sharing arrangements with other communications carriers. Revenues are primarily derived from: access, pooling, voice services, Universal Service Fund receipts, Internet and broadband services and other miscellaneous services. Local access charges are billed to local end users under tariffs approved by each state’s Public Utilities Commission (“PUC”). Access revenues are derived for the intrastate jurisdiction by billing access charges to interexchange carriers and to other local exchange carriers (“LECs”). These charges are billed based on toll or access tariffs filed with the local state’s PUC. Access charges for the interstate jurisdiction are billed in accordance with tariffs filed by the National Exchange Carrier Association or by the individual company and filed with the Federal Communications Commission (the “FCC”).

Revenues are determined on a bill-and-keep basis or a pooling basis. If on a bill-and-keep basis, the Company bills the charges to either the access provider or the end user and keeps the revenue. If the Company participates in a pooling environment (interstate or intrastate), the toll or access billed is contributed to a revenue pool. The revenue is then distributed to individual companies based on their company-specific revenue requirement. This distribution is based on individual state PUCs’ (intrastate) or the FCC’s (interstate) approved separation rules and rates of return. Distribution from these pools can change relative to changes made to expenses, plant investment, or rate-of-return. Some companies participate in federal and certain state universal service programs that are pooling in nature but are regulated by rules separate from those described above. These rules vary by state. Revenues earned through the various pooling arrangements are initially recorded based on the Company’s estimates.

Long distance retail and wholesale services can be recurring due to coverage under an unlimited calling plan or usage sensitive. In either case, they are billed in arrears and recognized when earned. Internet and data services revenues are substantially all recurring revenues and are billed one month in advance and deferred until earned.

As of September 30, 2011 and December 31, 2010, unearned revenue of $17.8 million and $15.3 million, respectively, was included in other accrued liabilities on the condensed consolidated balance sheet.

The majority of the Company’s miscellaneous revenue is provided from billing and collection and directory services. The Company earns revenue from billing and collecting charges for toll calls on behalf of interexchange carriers. The interexchange carrier pays a certain rate per each minute billed by the Company. The Company recognizes revenue from billing and collection services when the services are provided.

Internet and broadband services and certain other services are recognized in the month the service is provided.

Non-recurring customer activation fees, along with the related costs up to, but not exceeding, the activation fees, are deferred and amortized over the customer relationship period.

Service quality index (“SQI”) penalties and certain performance assurance plan (“PAP”) penalties are recorded as a reduction to revenue. SQI penalties for Maine, New Hampshire and Vermont are recorded to other accrued liabilities on the consolidated balance sheets. PAP penalties for Maine and New Hampshire are recorded as a reduction to accounts receivable since these penalties are paid by the Company in the form of credits applied to the Competitive Local Exchange Carrier (“CLEC”) bills. PAP penalties in Vermont are recorded to other accrued liabilities as a majority of these penalties are paid to the Vermont Universal Service Fund, while the remaining credits assessed in Vermont are paid by the Company in the form of credits applied to CLEC bills.

Revenue is recognized net of tax collected from customers and remitted to governmental authorities.

Management makes estimated adjustments, as necessary, to revenue or accounts receivable for billing errors, including certain disputed amounts.

(c) Restricted Cash

As of September 30, 2011, the Company had $26.2 million of restricted cash from which outstanding bankruptcy claims and various other bankruptcy related fees will be paid, $1.7 million of restricted cash for removal of dual poles in Vermont and $0.7 million of cash restricted for other purposes.

In total, the Company had $28.6 million of restricted cash at September 30, 2011 of which $27.9 million is shown in current assets and $0.7 million is shown as a non-current asset on the condensed consolidated balance sheet.

(d) Materials and Supplies

Prior to the Effective Date, materials and supplies included new and reusable supplies and network equipment, which were stated principally at average original cost, except that specific costs were used in the case of large individual items.

Materials and supplies of the Successor Company consist of finished goods and are stated at the lower of cost or market value. Cost is determined using either an average original cost or specific identification method of valuation.

(e) Property, Plant and Equipment

Prior to the Effective Date, property, plant and equipment of the Predecessor Company was recorded at cost. Depreciation expense was principally based on the composite group remaining life method and straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant, property and equipment less anticipated positive net salvage value, over the remaining asset lives. This method requires the periodic revision of depreciation rates.

When depreciable telephone plant used in the Company’s wireline network is replaced or retired, the carrying amount of such plant is deducted from the respective accounts and charged to accumulated depreciation. No gain or loss is recognized on disposition of assets.

Network software purchased or developed in connection with related plant assets is capitalized. The Company also capitalizes interest associated with the acquisition or construction of network related assets. Capitalized interest is reported as part of the cost of the network related assets and as a reduction in interest expense.

In connection with the Company’s adoption of fresh start accounting on the Effective Date, property, plant and equipment assets were revalued to their fair value, generally their appraised value after considering economic obsolescence, and new remaining useful lives were established. Accumulated depreciation was reset to zero. The appraisals assigned remaining useful lives to each asset ranging from two to twenty-three years. The revalued assets will be depreciated over these estimated remaining useful lives under the same method utilized for the Predecessor Company assets.

Property additions after the Effective Date are recorded and depreciated in a manner consistent with the Predecessor Company utilizing the estimated asset lives presented in the following table:


Category	Average Life (In Years)
Buildings		45
Central office equipment		5 – 11
Outside communications plant
Copper cable		15 – 18
Fiber cable		25
Poles and conduit		30 – 50
Furniture, vehicles and other		3 – 15

The Company believes that current estimated useful asset lives are reasonable, although they are subject to regular review and analysis. In the evaluation of asset lives, multiple factors are considered, including, but not limited to, the ongoing network deployment, technology upgrades and enhancements, planned retirements and the adequacy of reserves.

(f) Long-Lived Assets

Property, plant and equipment and intangible assets subject to amortization are reviewed for impairment as required by the Property, Plant and Equipment Topic of the ASC and the Intangibles Topic of the ASC. These assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. An impairment charge is recognized for the amount, if any, by which the carrying value of the asset exceeds its fair value.

As of December 31, 2010, as a result of changes to the Company’s financial projections related to the Chapter 11 Cases, the Company determined that a possible impairment of long-lived assets was indicated. In accordance with the Property, Plant and Equipment Topic of the ASC, the Company performed recoverability tests, based on undiscounted projected future cash flows associated with its long-lived assets and determined that long-lived assets were not impaired at December 31, 2010. See note 3(i) for further discussion.

Given the significant sustained decline in the Company’s stock price since the Effective Date which has caused the Company’s market capitalization to be below its book value, and both the September 30, 2011 impairment of goodwill and impairment of the FairPoint trade name, the Company determined that a possible impairment of long-lived assets was present as of September 30, 2011. See note 3(i) for further discussion of the September 30, 2011 impairment to goodwill and the FairPoint trade name. However, the Company concluded that long-lived assets were recoverable based on the fair value of the Company’s gross cash flows being greater than the carrying value.

(g) Computer Software and Interest Costs

The Company capitalizes certain costs incurred in connection with developing or obtaining internal use software which has a useful life in excess of one year in accordance with the Intangibles-Goodwill and Other Topic of the ASC. Capitalized costs include direct development costs associated with internal use software, including direct labor costs and external costs of materials and services.

Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance and training costs are expensed in the period in which they are incurred.

In addition, the Company capitalizes the interest cost associated with the period of time over which the Company’s internal use software is developed or obtained in accordance with the Interest Topic of the ASC. The Company did not capitalize interest costs incurred during the pendency of the Chapter 11 Cases, as payments on all interest obligations were stayed as a result of the filing of the Chapter 11 Cases. Upon entry into the Exit Credit Agreement on the Effective Date, the Company resumed capitalization of interest costs.

During the three months ended September 30, 2011, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, the Company capitalized $3.1 million, $11.5 million and $1.3 million, respectively, in software costs, $0.1 million in interest costs for the 249 days ended September 30, 2011 and less than $0.1 million in interest costs for the three months ended September 30, 2011. No interest costs were capitalized for the 24 days ended January 24, 2011.

(h) Debt Issue Costs

The Company entered into the DIP Credit Agreement on October 27, 2009. The Company incurred $0.9 million of debt issue costs associated with the DIP Credit Agreement and began to amortize these costs over the nine-month life of the DIP Credit Agreement using the effective interest method. Concurrent with the final order of the Bankruptcy Court, dated March 11, 2010 (the “Final DIP Order”), the Company incurred an additional $1.1 million of debt issue costs associated with the DIP Credit Agreement and began to amortize these costs over the remaining life of the DIP Credit Agreement using the effective interest method. On October 22, 2010, the Company incurred an additional $0.4 million of debt issue costs to extend the DIP Credit Agreement through January 2011. The Company has amortized these costs over the extended life of the DIP Credit Agreement.

On the Effective Date, the Company entered into the Exit Credit Agreement. The Company incurred $2.4 million of debt issue costs associated with the Exit Credit Agreement and began to amortize these costs over a weighted average life of 3.7 years using the effective interest method.

As of September 30, 2011 and December 31, 2010, the Company had capitalized debt issue costs of $1.9 million and $0.1 million, respectively, net of amortization.

(i) Goodwill and Other Intangible Assets

As of December 31, 2010, goodwill consisted of the difference between the purchase price incurred in the acquisition of Legacy FairPoint (FairPoint Communications, Inc. exclusive of the local exchange business acquired from Verizon and its subsidiaries after giving effect to the Merger (the “Northern New England operations”)), using the purchase method of accounting and the fair value of net assets acquired. Upon the Effective Date, goodwill consists of the difference between the reorganization value of the predecessor company and the fair value of net assets using the acquisition method of accounting for business combinations in the Business Combinations Topic of the ASC. In accordance with the Intangibles — Goodwill and Other Topic of the ASC, goodwill is not amortized, but is assessed for impairment at least annually.

In September 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-08 to amend and simplify the annual testing for goodwill impairment. This amendment to Intangibles — Goodwill and Other Topic of the ASC allows an entity the option to first assess qualitative factors to determine whether the existence of events and circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, after assessing the totality of events and circumstances, an entity determines it not likely that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test. In addition, the ASU includes examples of events and circumstances that an entity should consider in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. These events and circumstances should be utilized when an entity considers the need to test goodwill for impairment between annual tests.

Goodwill impairment is determined using a two-step process. Step one compares the estimated fair value of the Company’s single reporting unit (calculated using both the market approach and the income approach) to its carrying amount, including goodwill. The market approach compares the fair value of the Company, as measured by its market capitalization, to the carrying amount of the Company, which represents its stockholders’ equity balance. The income approach is based upon projected future cash flows discounted to present value using factors that consider the timing and risk associated with the future cash flows. The fair value of the Company’s single reporting unit was estimated using a probability weighted scenario of future cash flow projections based on management’s long range estimates of market conditions over a multiple year horizon. An estimated growth rate was used to arrive at an estimated terminal value. A discount rate was based upon a cost of capital calculated using various inputs, such as the risk-free rate, equity risk premium, size premium, company specific premium, etc., as of the date of the goodwill impairment test.

Effective January 1, 2011, step one of the goodwill impairment test was amended for reporting units with zero or negative carrying amounts. Previously, for those reporting units, an entity would not be required to perform step two of the goodwill impairment test. Now, an entity is required to perform step two of the goodwill impairment test for reporting units with zero or negative carrying amounts if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist.

Step two compares the implied fair value of the Company’s goodwill (i.e., the fair value of the Company less the fair value of the Company’s assets and liabilities, including identifiable intangible assets) to its goodwill carrying amount. If the carrying amount of the Company’s goodwill exceeds the implied fair value of the goodwill, the excess is required to be recorded as an impairment.

During this assessment, management relies on a number of factors, including operating results, business plans and anticipated future cash flows. The Company performed step one of its annual goodwill impairment assessment as of October 1, 2010 and concluded that there was no impairment at that time. At December 31, 2010, the Company had goodwill of $595.1 million.

In connection with the Company’s adoption of fresh start accounting on the Effective Date, goodwill of the Predecessor Company was eliminated. On the Effective Date, the Company recorded $256.0 million of goodwill in connection with the Company’s adoption of fresh start accounting. During the second quarter of 2011, the Company made a $12.8 million reclassification adjustment to Property, Plant and Equipment based on fresh start accounting guidance which reduced the goodwill to $243.2 million.

At September 30, 2011, as a result of the significant sustained decline in the Company’s stock price since the Effective Date, which has caused the Company’s market capitalization to be below its book value, the Company determined that a possible impairment of goodwill was indicated and concluded that an interim goodwill impairment test was necessary. In step one, the Company calculated the discounted cash flows to arrive at a fair value, which was then compared to the carrying value, including goodwill. A combination of expected cash flows and higher discount rates resulted in the fair value, using the discounted cash flow method, being less than the carrying value, at which point the company proceeded to step two, as outlined above. Results of the impairment test required the Company to record an impairment charge reducing the carrying value of the goodwill to zero at September 30, 2011. This non-cash impairment charge has no impact on the Company’s compliance with the covenants contained in the Exit Credit Agreement.

The goodwill impairment falls within Level 3 of the fair value hierarchy (see note 12), due to the use of significant unobservable inputs to determine fair value. The fair value measurement was calculated using unobservable inputs, primarily using the income approach and specifically the discounted cash flow method.

In connection with the Company’s adoption of fresh start accounting on the Effective Date, intangible assets and related accumulated amortization of the Predecessor Company were eliminated. Intangible assets of the Successor Company were identified and valued at their fair value, as determined by valuation specialists. The Company’s intangible assets are as follows (in thousands):


	Successor Company		Predecessor Company
	At		At
	September 30,		December 31,
	2011		2010
Customer lists (weighted average 9.0 years and 9.7 years for Successor Company and Predecessor Company, respectively):
Gross carrying amount	$	99,000	$	208,504
Less accumulated amortization		(7,541)		(62,073)

Net customer lists		91,459		146,431

Trade name (indefinite life):
Gross carrying amount		39,169		42,816


Favorable leasehold agreements (weighted average 2.7 years):
Gross carrying amount		410		—
Less accumulated amortization		(105)		—

Net favorable leasehold agreements		305		—


Total intangible assets, net	$	130,933	$	189,247

The Company assesses the fair value of the trade name based on the relief from royalty method. If the carrying amount of the trade name exceeds its estimated fair value, the asset is considered impaired. The Company performed its annual non-amortizable intangible asset impairment assessment as of October 1, 2010 and concluded that there was no indication of impairment at that time. As of December 31, 2010, as a result of changes to the Company’s financial projections related to the Chapter 11 Cases, the Company determined that a possible impairment of its non-amortizable intangible assets was indicated. The Company performed an interim non-amortizable intangible asset impairment assessment as of December 31, 2010 and determined that the trade name was not impaired. On the Effective Date, the Company recorded a $58.0 million non-amortizable intangible asset related to the FairPoint trade name in connection with the Company’s adoption of fresh start accounting.

At September 30, 2011, as a result of the significant sustained decline in the Company’s stock price since the Effective Date which has caused the Company’s market capitalization to be below its book value, the Company determined that a possible impairment of the FairPoint trade name was indicated and concluded that an interim impairment test was necessary. Results of the impairment test required the Company to record an impairment charge totaling $18.8 million at September 30, 2011.

The trade name impairment falls within Level 3 of the fair value hierarchy (see note 12), due to the use of significant unobservable inputs to determine fair value. The fair value measurement was calculated using unobservable inputs, using the relief from royalty method.

For its non-amortizable intangible asset impairment assessments of the FairPoint trade name, the Company makes certain assumptions including an estimated royalty rate, a long-term growth rate, an effective tax rate and a discount rate, and applies these assumptions to projected future cash flows, exclusive of cash flows associated with wholesale revenues as these revenues are not generated through brand recognition. Changes in one or more of these assumptions may result in the recognition of an impairment loss different from what was actually recorded.

The Company’s amortizable intangible assets consist of customer lists and favorable leasehold agreements. Amortizable intangible assets must be reviewed for impairment whenever indicators of impairment exist. See note 3(f) above.

(j) Accounting for Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

FairPoint files a consolidated income tax return with its subsidiaries. FairPoint has a tax-sharing agreement in which all subsidiaries are participants. All intercompany tax transactions and accounts have been eliminated in consolidation.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management determines its estimates of future taxable income based upon the scheduled reversal of deferred tax liabilities and tax planning strategies. The Company establishes valuation allowances for deferred tax assets when it is estimated to be more likely than not that the tax assets will not be realized.

(k) Stock-based Compensation Plans

The Company accounts for its stock-based compensation plans in accordance with the Compensation-Stock Compensation Topic of the ASC, which establishes accounting for stock-based awards granted in exchange for employee services. Accordingly, for employee awards which are expected to vest, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense on a straight-line basis over the requisite service period, which generally begins on the date the award is granted through the date the award vests.

On the Effective Date, the Company issued options to purchase shares of New Common Stock to certain employees, a consultant and members of the New Board, pursuant to the terms of the Long Term Incentive Plan. The grant date fair value of the options was determined using the Black-Scholes model. Key assumptions used for determining the fair value of the options were as follows: risk-free rate—2.7%; expected term—7 years; expected volatility—45.0%.

(l) Employee Benefit Plans

The Company accounts for pensions and other post-retirement benefit plans in accordance with the Compensation — Retirement Benefits Topic of the ASC. This Topic requires the recognition of a defined benefit post-retirement plan’s funded status as either an asset or liability on the balance sheet. This Topic also requires the immediate recognition of the unrecognized actuarial gains and losses and prior service costs and credits that arise during the period as a component of other accumulated comprehensive income, net of applicable income taxes. Amounts recognized through accumulated comprehensive income are amortized into current income in accordance with the Compensation — Retirement Benefits Topic of the ASC. Additionally, a company must determine the fair value of plan assets as of the Company’s year end.

(m) Business Segments Management views its business of providing video, data and voice communication services to residential, wholesale and business customers as one business segment as defined in the Segment Reporting Topic of the ASC. The Company’s services consist of retail and wholesale telecommunications services, including voice and HSD in 18 states. The Company’s chief operating decision maker assesses operating performance and allocates resources based on the consolidated results.

(n) Other Long-Term Liabilities

As a result of fresh-start reporting, the Company recorded $13.0 million in unfavorable union contracts and $0.7 million in unfavorable leasehold agreements, each of which resulted from agreements with contract rates in excess of market value rates as of the Effective Date. Amortization is recognized on a straight-line basis over the remaining term of the agreements, ranging from 1 to 7 years, as a reduction of employee expense and rent expense within operating expenses.